The Potential Disadvantages of FHA Home Loans
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FHA home loans are often touted as the perfect mortgage loan for first-time homebuyers. Certainly, they do have some advantages over conventional mortgage loans. You can make a down payment as low as 3.5% of the purchase price. You have an easier chance of getting approved if your credit score is below prime. But there are certain disadvantages to FHA loans as well, and that's what I'd like to talk about in this article.
First, the Benefits of FHA Loans
We will get to the disadvantages of FHA home loans in just a moment. But first, I want to expand on the benefits I touched on above. One of the biggest benefits of using an FHA loan is the fact that you minimize your down-payment expense. For a conventional mortgage loan (one that is not insured by the government), you will probably have to put down at least 5% of the purchase price. Some lenders are even requiring a minimum of 10% down.
But with the FHA home loan, you could put as little as 3.5% down on the mortgage loan. Starting in 2011, you will need a credit score of 580 or higher to qualify for the 3.5% down-payment option. If your score is below 580, you will be required to put down at least 10% for an FHA loan. But for those who meet the credit score requirement, the smaller down payment is a major benefit of using an FHA loan.
It's also easier to qualify for an FHA loan when your credit is shaky. To get a conventional mortgage loan, you will probably need a credit score of 620 or higher. But when using an FHA loan, you could get qualified with a score slightly below that. This is the second-most common reason why people use this loan program in the first place. They simply don't qualify for a conventional mortgage based on their credit score, so they turned to the FHA program instead.
Disadvantages Of This Financing Option
Now that we've covered the pros, let's talk about some of the cons. Here are some of the disadvantages of using an FHA home loan to buy a house.
1. Higher Interest Rates
You will probably be assigned a higher interest rate than if you had used a conventional mortgage loan. The rate you receive will also be influenced by your credit score and other factors. But the simple fact that you're using an FHA loan generally means you'll get a higher interest rate.
2. Mortgage Insurance Premiums - Two of Them
You will have to pay mortgage insurance on the loan. In fact, you have to pay two types of mortgage insurance when using an FHA loan. You'll have an upfront mortgage insurance premium for 1% of the loan amount, as well as an annual premium for 1.1% - 1.15% of the loan amount (these were increased in April 2011).
As the name implies, the upfront premium gets paid when you close on the home. The annual premium is broken down into monthly portions and added on to your mortgage payment.
Granted, if you use a conventional mortgage loan with less than a 20% down payment, you will also face mortgage insurance charges. But the premiums for FHA loans are generally higher than those for conventional mortgages. This is another disadvantage of the FHA home loan program.
3. Condo Restrictions
Some condominiums do not meet FHA approval standards. The FHA is very strict about the type of condos they are willing to allow for their home loans. So this may limit your options if you choose this financing path. The rules for condos change all the time, so I'm not inclined to try to list them all here. If you do a Google search for "FHA guidelines for condos," you should find the proper page of the HUD website with the most current information.
4. The Multiple-Offer Disadvantage
An FHA loan can be a disadvantage if there are multiple offers on the house. In particular, if a homeowner has equal offers from buyers with conventional mortgages, he might choose the conventional loan over the FHA borrower.
Some of this is simply due to an outdated stigma that is still lingering in the real estate world. In the past, sellers were often required to pay a significant portion of the buyers' closing costs, if an FHA loan was used. This is not necessarily the case today. The FHA allows the buyer to cover nearly all of their own closing costs these days. The buyer might still try to negotiate for the seller to cover those costs, but it's not required by the FHA. Like I said, it's an old stigma that is still around.
The home inspection requirements for FHA loans are generally more rigorous than those for conventional mortgages. In fact, there isn't an inspection requirement for conventional mortgages -- it's totally up to the buyer. But the inspection will be mandatory (and probably more involved) with an FHA loan.
Anytime you deal with the government, you have more red tape involved. For these reasons, sellers have been known to shy away from borrowers with FHA home loans.
Of course, you have to understand the type of real estate market you're in. If you are in a slow market with very few buyers, the seller probably won't care what kind of mortgage you have -- as long as you've been approved for the loan. In these cases, the homeowner has to take whatever she can get. But if you're in a more active real estate market where multiple offers are a reality, then the FHA loan could be more of a disadvantage sure you.
Do the Pros Outweigh the Cons?
This is what it all comes down to. You just have to ask yourself if the benefits of an FHA home loan outweigh the potential disadvantages of the program. If you can't come up with a 10% down payment, then the FHA program might be the best option for you. In that case, you would just have to take the disadvantages in stride.
And, as mentioned earlier, there might not even be any disadvantages of using the FHA loan. If you're in a buyer's market where houses are staying on the market for a long time, you should have no trouble getting the seller to accept your offer -- regardless of the type of loan you are using.
I recommend that you continue your research on this website and elsewhere. We have dozens of FHA-related mortgage articles on this website, and you can find other useful resources online with a quick Google search. Once you've spent some time researching the FHA home loan program, you'll be able to decide if it's the right path for you. You'll be able to weigh the advantages against the disadvantages to make an informed decision. And that's how you make smart decisions.